Japan goes to an election accompanied by a very confused economic debate

These notes will serve as part of a briefing document that I will send off to some interested parties in Japan. Japan is about to go to the poll for a snap national election on February 8. The recently installed Prime Minister, Ms Takaichi is betting that her recent solid showing in the polls will allow her to capture more seats in the Diet and reduce or even eliminate her dependency on the ‘uncomfortable’ coalition partner, the Japan Innovation Party (JIP) aka Ishin. That coalition was formed after Mr Ishiba, the previous PM, also bet on a snap election result, which saw the ruling Liberal Democratic Party (LDP) go backwards (losing 68 seats) and the coalition partner Komeito also lose seats. Together the ruling coalition lost its majority in the National Diet (for the first time since 2009) and Shigeru Ishiba’s popularity began to evaporate. The background to that loss was a major political funding scandal among the Cabinet ministers and the election result signalled that the Japanese people had seemingly had enough of the corruption at the top. Ms Takaichi took over after Mr Ishiba could no longer sustain his position as PM. The old coalition between the LDP and Komeito fell apart because the Buddhist Komeito could no longer stomach the new PMs imperialist ideology nor her unwillingness to deal with he insidious corruption in her party. This forced Ms Takaichi to forge a new coalition – hence the rather unlikely pairing with Ishin, which is a right wing populist party espousing neoliberal economic policies. The government is proposing a major fiscal expansion but the debate during the campaign that is now underway is very confused. The confusion arises because all the main players keep wheeling out mainstream economic arguments that tie them up into nonsensical policy proposals.

State of the debate

In the lead up to the next election, several new party arrangements have emerged, which I won’t examine here.

The LDP, which currently has 196 seats in the 465 seat Diet, aim to win at least a further 38 seats which would give it a majority in its own right.

The prospects for the LDP are probably good because the main opposition parties are not in good shape and the other opposition parties are too fragmented to combine into anything threatening.

But the state of the debate is appalling and that is what this blog post is about.

I am confining the discussion to the economic debate only, leaving all the stuff about Taiwan and immigration aside – you can guess my views on those topics.

At the symposium that we held at the Diet in November 2025, I urged the Cabinet to abandon the sales tax as one very effective way of breaking the austerity mindset that has crippled the economy since the 1990s.

I also advocated along with the other two speakers (Professor Fujii and Dr Matsumoto) that the fiscal injection should be considerably larger than was, at that time, being advocated by the LDP policy brokers.

In the week that followed, the scale of the stimulus was increased considerably, which was a good move.

And, now with an election coming up, Ms Takaichi has gone to the polls with a promise to suspend the 8 per cent sales tax on food for a period of two years, starting in the current fiscal year.

She has then promised to introduce a refundable tax credit program which will help the lower income households cope with the cost-of-living pressures.

While I argued for this shift in policy when I was in Tokyo, the rationale being advanced by Ms Takaichi and her advisors for the move is flawed.

The PM said that while she acknowledges that the suspension of the sales tax will reduce government revenue by around ¥4.8 trillion, she also plans to reduce some subsidies and tax concessions to offset the reduction.

In other words, the sales tax move is not an expansionary shift in fiscal policy, which runs counter to the recommendation we made at the November workshop at the Diet.

It is clear that the Ministry of Finance has been arguing along mainstream lines that the government cannot afford to increase its deficit and increase its public debt ratio.

Mainstream economists are claiming that the rising bond yields in Japan at present are a sign that the ‘markets’ have had enough of the rising debt and want to discipline the government to follow an austerity strategy.

Japan is currently locked in a state of secular stagnation.

It is characterised by:

1. Corporations sitting on massive retained earnings and refusing to invest in an expansion of productive capacity and productivity growth.

2. As a result the same corporations refuse to create new permanent jobs and have increasingly relied on what the Japanese refer to as non-regular employment – which the rest of us call precarious, casualised, low-pay, low productivity employment.

3. The low pay and gloomy prospects, in turn, means households are reluctant to increase their consumption spending and save a lot.

4. This deflationary mindset is now entrenched in Japanese society.

To break that mindset in both corporations and households, the economy needs a big shock – that can only really come from a substantial and targeted fiscal expansion.

It is hard to see how that will happen if the mainstream thinking in the Ministry of Finance, which has permeated the thinking of the Cabinet, persists.

But the debate in Japan is being dominated by mainstream economists, especially as bond yields have been rising.

It is easy for them to seize on the rising yields as evidence that fiscal policy is too lax and some harsh austerity is required.

After all, they have been claiming that the causality runs from high deficits to rising bond yields.

The logic is that the bond yields reflect the expectations of the bond investors and the higher is the outstanding public debt, the higher is the risk of default.

To compensate the investors for the increased risk, bond yields have to rise.

That is the mainstream logic.

The problem is that the claimed causality is incorrect.

There is no credit risk involved in holding Japanese government bonds.

There is also very little exchange rate risk involved because the bonds are largely held by domestic investors trading in yen.

Why then are the yields rising?

First, the Bank of Japan is now engaged in what it calls a normalisation of its interest rate policy.

This reflects the fact that the policy rate has been held at around zero for many years as the economy fought with chronic deflation.

It is now slowly increasing its policy rate towards an implicit target of 1 per cent or so.

The Bank considers that the economy is moving towards a steady inflation rate consistent with its target 2 per cent and that wages growth is finally showing some signs of becoming more consistent.

You can read about this in the – Minutes of the Monetary Policy Meeting on October 29 and 30, 2025 – issued by the Bank of Japan on December 24, 2025.

It is thus running a balancing act between tightening too much (as it manages the value of the yen in foreign exchange markets) and achieving its policy rate goals.

I should add that the whole concept of ‘normalisation’ is fraught.

There was no crisis that the Bank had to address and it should have held rates at around zero indefinitely and maintained its government bond purchasing program.

Second, as part of this process, it is also reducing the assets held on its balance sheet – selling off government bonds and commercial debt that it built up over several years of quantitative easing.

This is the so-called normalisation of the yield curve which means that by reducing its demand for government bonds in the secondary markets (and adding to supply through its sell-off plan), the bank is suppressing bond prices.

Given that bond yields are inversely related to price, it follows that the yields on the bonds, especially those in the maturity range that the Bank is off-loading will rise.

Why are government bond yields inverse to price?

The standard government bond has three parameters: (a) the face value – say $A1,000; (b) the coupon rate – say 5 per cent; and (c) some maturity – say 10 years.

Taken together, this public debt instrument will provide the bond holder with $50 dollar per annum in interest income for 10 years whereupon they will get the $1000 face value returned.

Bonds are issued by government into the primary market, which is simply the institutional machinery via which the government sells debt to a select group of investors (mostly banks).

In a modern monetary system with flexible exchange rates it is clear the government does not have to finance its spending so the the institutional machinery is voluntary and reflects the prevailing neo-liberal ideology – which emphasises a fear of fiscal excesses rather than any intrinsic need.

Most primary market issuance is via auction. Accordingly, the government would determine the maturity of the bond (how long the bond would exist for), the coupon rate (the interest return on the bond) and the volume (how many bonds) being specified.

The issue would then be put out for tender and the market then would determine the final price of the bonds issued.

Imagine that the market wanted a yield of 6 per cent to accommodate risk expectations (inflation or something else).

So for them the example bond above is an unattractive proposition at $A1,000 and under the tender or auction system the bond investors would put in a purchase bid lower than the $1000 to ensure they get the 6 per cent return they sought.

Alternatively if the market wanted security and considered the coupon rate on offer was more than competitive then the bonds will be very attractive.

Under the auction system they will bid higher than the face value up to the yields that they think are market-based.

Once the bond is issued and is then traded between investors in the secondary bond market, its price fluctuates accordance with demand and supply, even though its face value remain fixed at the value at the time of issue.

If returns on assets are rising elsewhere in the financial markets – for example, because the interest rate is rising, then the price of a bond can change in the market place according to these interest rate fluctuations.

So the 5 per cent yield on the $A1,000 bond delivers a $A50 return each year.

But if interest rates in the economy rise to say 6 per cent, then the fixed yield of $A50 will not be adequate and the bond price will be bid down around $A833 so that the fixed coupon payment will generate a 6 per cent return.

Third, the government has been managing expectations as Ms Takaichi embarks on her ambition to achieve ‘responsible and proactive public finance’ and use a fiscal expansion to kick-start the economy and shift the growth plane from a low 1 per cent to 3 per cent.

The constant narrative coming out of the government is shifting the investment expectations and it is now considered likely that Japan will break out of its deflationary bias and achieve a steady 2 per cent inflation trajectory.

As a result, the yields on long-term debt are adjusting upwards with this new growth scenario – longer yields are higher to offset the inflationary effect on the income streams.

Thus the rising yields have little to do with fears of insolvency or elevated credit risk pertaining to fiscal policy settings.

In fact, they reflect a confidence that the proposed fiscal expansion that Ms Takaichi is pursuing will have positive impacts on economic growth.

The mainstream debate has misunderstood this dynamic completely.

The Coalition partner JIP (Ishin) is also peddling fiction.

It recently criticised the proposal of the newly created – Centrist Reform Alliance (CRA) – to permanently abandon the sales tax on food.

The CRA is the hastily stitched together combination formed on January 15, 2026 of the Constitutional Democratic Party of Japan and the former Coalition partner Komeito.

There political stance is defined by the concept of – Chūdō – or in Japanese Buddhist parlance – the ‘middle way’, which translates into their political approach to “aim for consensus building among diverse opinions, rather than creating division or conflict”.

Komeito is the political arm of – Soka Gakkai – a derivative Buddhist group in Japan that began in 1930.

The JIP claimed that the CRA’s plan to use returns from the government’s pension reserve fund to offset the loss of revenue from the sales tax cut would not realise sufficient revenue.

Further they claimed that the returns have to be re-injected into the pension system to ‘prop up’ the system as the population gets older.

You can see the twin sources of fiction.

First, CRA thinks the tax revenue from the sales tax is somehow important and has to be replaced.

Second, JIP thinks that the pension system would collapse if there is not sufficient market returns to generate revenue from the existing pension fund.

Both claims are based on the false belief that the Japanese government is financially constrained in its spending.

The lost tax revenue might be important if it leads nominal spending in the economy to rise to quickly relative to the productive (supply) capacity – which would generate inflationary pressures.

But given the nation is still fighting deflation and domestic demand is relative weak, that prospect is not particularly pressing.

It would be better for the government to just scrap the sales tax (as I recommended at the Tokyo Symposium in November 2025) and assess the expansion that it engendered.

The other main political party, the centre-right – Democratic Party for the People (DPP) – has also jumped on the cut the sales tax band wagon and is proposing reducing the taz to 5 per cent.

It has several proposed offsets including deploying the exchange-traded funds (ETFs) held by the Bank of Japan (BOJ) to provide the revenue offset.

I discussed the ETF issue in this recent blog post – Bank of Japan’s ETF sell-off is a sideshow (September 25, 2025).

The DPP is just another actor entering that sideshow on this issue.

Conclusion

While I will watch the election very closely, the debate in the lead up has been anything but interesting.

It has been mired by the dominance of these mainstream arguments that do not relate to reality.

That is enough for today!

(c) Copyright 2026 William Mitchell. All Rights Reserved.